ANALYSIS: Next week the Reserve Bank will review the Official Cash Rate, and the near-universal expectation is that it will cut the OCR from 3.25% to 3%. The rate has been falling from 5.5% since exactly this time a year ago in response to deep weakness in the economy which the Reserve Bank did not predict or recognise happening until six months after it started, plus falling inflation.
I specifically mention two factors as being behind interest rate cuts. The state of the economy and inflation. The two are heavily intertwined, with inflation usually strongly influenced by the state of the economy and the economy then influenced by the direction the central bank wants inflation to go.
At the moment, almost everyone is focusing on the still fraught state of the New Zealand economy. Unemployment is up (though the jobless rate still low by historical standards), Kiwis are leaving for Australia (though the net flow for all nationalities is still net 15,000 positive), businesses continue to fail (many because they have waited too long to restructure after the ending of the unsustainable pandemic boom), and not everyone has achieved average wages growth this past year of 4.5%.
Start your property search
Find your dream home today.
To many, it seems obvious that there should be further cuts to interest rates. But they may be wrong. Consider first that inflation is still at an above-average 2.7%, despite weaknesses in the economy. Once economic growth picks up, inflation will rise, and even allowing for some special one-offs boosting prices recently (butter for instance), the outlook for inflation beyond 2026 is not good.
Discover more:
– Who are the biggest house price winners and losers of the last 10 years?
– Former gang town is NZ’s hottest suburb – why house prices quadrupled
– Wealthy women in New Zealand: How they made their money, how they are spending it
It also pays to recognise that over the past three years New Zealand’s level of productivity has gone down. There is no productivity growth in our economy. That means for every given level of growth in our output, there will be extra upward pressure on prices.
Third, as discussed here many times over the past year, business margins are extremely tight. One measure I calculate shows margins at their worst levels since at least 1970. A well above-average proportion of businesses are reporting that they plan to raise their prices next year, and that is something which the Reserve Bank will keep in mind as it assesses monetary policy.
Independent economist Tony Alexander: “Inflation is still at an above-average 2.7%, despite weaknesses in the economy.” Photo / Fiona Goodall
None of these arguments preclude further cuts to the OCR after next week’s likely reduction. But they do mean this. If rates get cut to, say, 2.5% in the next six months, then borrowers should anticipate relatively quick increases once we get into 2027. If the cash rate stays at 3% or above, then those rises will be more gradual once the tightening cycle restarts.
Given the considerable uncertainty regarding the economic outlook, where inflation is headed, and what policy choice the Reserve Bank will make, borrowers should give strong consideration to splitting their interest rate fixes across more than one period of time.
Most people just fix for one term and currently the preferred time periods are 12, 18, and 24 months. But fixing for just one term means any shock change in interest rates come renewal time will hit all at once. If the fixing is split across more than one term, then time is bought to make some lifestyle and spending adjustments in a more planned and unpanicked manner.
That is, splitting one’s mortgage rate across different terms will almost never prevent a change in interest rates from feeding through. But the practice will buy some adjustment time.
– Tony Alexander is an independent economics commentator. Additional commentary from him can be found at www.tonyalexander.nz